Company promoters can no longer go scot free

(Apr 3, 2010)

In this issue:
» China's central bank warns of asset bubbles
» March economic data points to a stronger global recovery
» Remittances by Indian expats surge in 2009
» Bankers may urge RBI not to hike its key rates
» ...and more!

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00:00

There may not be too many readers of The 5 Minute Wrapup identifying with this. For we guess most of them have not had the ill experience of investing in Indian stocks before the crisis of 1997-98. Most investors of 1997-98 never returned back to investing in stocks. That was a time when a host of Indian companies went belly up. As per its website, a total of 1,445 companies were referred to the BIFR (Board for Industrial and Financial Restructuring) between 1997 to 2000. They were unable to service the burden of high cost debt taken to finance ambitious capex.

This time around things are certain to be different. Irrespective of the upward movement of interest rates. Irrespective of the snail-paced economic recovery in the West. Indian companies this time around have very reasonable leverage ratios. Their high operating efficiency will help them comfortably absorb the incremental costs. But most importantly they will have more responsible promoters. Ones who will not go scot free for taking bad business decisions.

The biggest mistake that led to the crisis of 1997-98 was that of promoters' oversight of business cycles. They failed to foresee the drop in demand and rise in borrowing costs. When reality struck, the promoters failed to remain answerable. Banks bore heavy losses by way of NPAs. And the companies went bankrupt. Shareholders were left with no solace for the loss of their life's savings.

But not anymore. The RBI has this time around made restructuring of debt by companies tougher. Promoters will now have to make up for bad balance sheet decisions. The promoters will have to pay up atleast 15% of the money the banks will lose due to recasting of debt. For one, this will discourage them from taking excess debt. Secondly this will protect the banks' interest as well. For shareholders there could be nothing better than having responsible promoters being answerable for their decisions.

01:12

Chart of the day

As today's chart of the day shows, 2010 marks the first time in the history of mankind when more people in the world will live in modern cities rather than in rural areas. This trend has been very pronounced globally since the 1950s, and is expected to continue well into the future. While most of this urbanisation in the past has come from the developed western world, we expect most of this incremental urbanisation in the future decades to come from developing countries like India and China. It is a well established fact that in general, the level of consumption is much higher in an urban population when compared to rural folk. Thus the good news for our own companies back here in India is that as more and more people living in India's vast hinterland move towards a more modern lifestyle over the long term, we can surely expect a huge expansion of not only consumption but also of corporate India's customer base, and consequently its earnings.

Data Source: Earth Policy Institute

01:50

Thus far, experts around the globe have been hinting at a bubble in the Chinese economy with its stimulus measures stoking inflation and runaway asset prices. One indication of the same is that property prices in 70 major Chinese cities have climbed the most in almost two years. Now China's central bank has itself joined the chorus as in a recent report. It says, "Ultra-loose monetary policies by governments around the world don't mean real economies have recovered or will recover strongly". It goes on to add that asset price gains, "unless they receive sufficient support from macroeconomic fundamentals, may lead to a new round of asset bubbles that may burst". We cannot agree more. But the question is whether the political leadership in any country can risk the wrath of its population by risking the fledgling economic recovery underway. The Chinese leadership is also not an exception. In fact, the Chinese premier Wen Jiabao has recently pledged to maintain a ‘moderately loose' monetary policy this year to solidify China's recovery. As they say, words are cheap, its action that counts.

02:31

And so, to end or not to end the stimulus, that is the question. While some fear the ill-effects of excess liquidity sloshing in the system, others believe that lower liquidity will affect the recovery process. One set of people who are want the liquidity to continue is the bankers. As per a leading business daily, bankers are likely to urge the RBI not to hike its key rates and cash reserve requirement in its upcoming annual policy measures. Bankers fear that lesser liquidity will lead to a sharp rise in lending rates, there by affecting their business. It may be noted that RBI has already initiated an exit from the stimulus measures. It hiked the cash reserve ratio (CRR) by 0.75% to 5.75% in January and recently hiked its short-term rates by 0.25%. On the other hand it has recently provided relief to banks lending to the infrastructure sector, by easing norms on asset classification (bad loans) in infrastructure loans. Clearly, the central bank needs to strike a fine balance in this area.

03:12

If economic data for the month of March from across the world is to be relied on, the global recessionary environment may finally be coming to an end. As per Bloomberg, while manufacturing in China grew for a 13th month in March 2010, production by US factories expanded the most since July 2004. Business sentiment in Japan too rose to the highest level since 2008. Many indices constructed to reflect economic activity like purchasing, manufacturing and business sentiment in different parts of the world have also seen higher than expected rises in the month gone by. It does not end there. Pleasant surprises also emanated from the sluggish Euro region. Factories in Britain, Germany and the euro region saw a step up production. In Switzerland, a measure of manufacturing activity jumped last month to the highest in more than three years, while Ireland's manufacturing industry grew for the first time since 2007. While economic activity seems to finally be on the rise, its sustainability is what remains to be seen.

03:52

India's resilience during the global financial maelstrom has not only attracted the attention of companies from all over the world, it also seems to have won back the faith India's very own citizens who have settled down in different parts of the world. Inward remittances by Indian expats have continued to surge at a higher than expected rate. Indians remitted about US$ 55 bn in 2009, around 17% higher than what the World Bank had projected for the year. Further, India continues to be the top remittance receiving country in the world. Perhaps an implicit sign that India's abroad consider India as much more safe and stable economically than many of the other countries they may currently inhabit.

04:24

World markets ended the week past by on a positive note as investor sentiments were boosted by the positive economic data. The key ones were that of an increase in China's Purchasing Managers' Index and a rise in consumer spending in the US. This signs of recovery also led to commodity prices (crude oil and metals) to rise sharply during the week. While India's benchmark index, the BSE-Sensex also managed to record gains during the week, it was amongst the lowest gainers. The BSE-Sensex ended higher by about 0.3%.

With gains of about 4%, Brazil's benchmark index was the top gainer this week. It was followed by Asian markets namely China (up 3%), Japan (up 3%) and Hong Kong (up 2%). Germany, France and UK ended higher by about 1% each. US markets ended the week with gains of about 1%.

Data source: Yahoo Finance, Kitco

04:52

Weekend investing mantra

"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak." - Warren Buffett

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Out of Rs. 100/* eaten away or swindled, one has to pay out only Rs 15/*. Its a good deal. More promoters may join the Q. Instead of doing business, they earn more and quickly too. Poor small investors will continue to suffer unless stringent measures like 'imprisonment of such economic offenders' and 'attachment of their illgotten wealth', such practices will continue to flourish.

For the benefit of the new crop of investors the harrowing experience several keen investors had during the late 1990s has been recalled to memory. It is good news that the situation has changed and the company promoters can no longer go scot free.

Urbanisation having become an unstoppable trend even in developing countries, India cannot be an exception. With the bright prospect of the level of consumption going up,Corporate India's consumer base is bound to swell. It augurs well for the future of the country.

You are saying that Promoters will be answerable to shareholders It sounds like a joke because shareholders seldom attend meetings or even respond to ballot voting. In my humble opinion the whip of the Promoters will continue to have sullen effects on the minority and it is very difficult to suggest an alternative. May be institutional nominees or real honest independent directors can protect the small investors

I am certainly amused at the confidence with which this article put a touching faith in the RBI decision regarding promotors bringing in 15%. Most of the companies which went belly up are promoted by crooks and given respecatability by media and such people will continue to con investors. The promotor who would have certainly made good amount of money by over invoicing purchases and under invoicing sales would by then built up good amount of cushion for such commitments. This is not going to do anything good for investors. It can only lull them to over confidence and buy all kinds of dubious company shares

For the past couple of days, I have been reading the contents of Equitymaster on different aspects, may they be on worldwide economy, stock market and the likes. By now, reading the Equitymaster has become a very good learning experience and a way of life. May God bless the Equitymaster Team which invariably works so hard to wisen its readers from time to time.

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